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Plus, WorldCom gets caught in a storm; executives are asked to swear; securities suits target nontechs; and more
CFO Staff, CFO Magazine
August 1, 2002
Weekdays as corporate monikers aren't just for chain restaurants like TGI Friday's or Ruby Tuesday anymore. PwC Consulting, which is expected to spin off from parent PricewaterhouseCoopers LLP this month, recently announced it will be named "Monday."
The move has garnered its share of criticism from those who associate Monday with the dread of returning to work. Lucy Kellaway of the Financial Times called it "beyond parody" in a June 17 column.
PwC, however, isn't wavering. "It's about making a fresh start," says spokesperson Sehra Eusufzai.
The new firm should at least be applauded for attempting to reset the name game, says Jay Jurisich of branding consultancy A Hundred Monkeys. "It takes a lot of guts for PwC to turn against the tide of phony names." He says made-up names, like Accenture, are "generally selected to appease people."
For its part, Accenture is just happy to have no association with Arthur Andersen anymore. It does, however, have an association with Monday. The rival IT consulting firm quickly registered www.moday.com in hopes of skimming some business from those who mistype the name. They're expecting plenty of hits on Monday morning. -- Joseph McCafferty
Sign of the Times?
Investors aren't the only ones swearing after news of WorldCom's woes. In June, furious at the widening corporate accountability scandal, the Securities and Exchange Commission ordered CFOs and CEOs at 945 companies to file sworn statements--starting this month--attesting to the truth of their most recent annual and quarterly reports.
So far, the order applies only to this year. But, says Douglas M. Hagerman of law firm Foley & Lardner, "a requirement to certify SEC filings under oath is a serious wake-up call to CEOs and CFOs everywhere."
The order, with its implied threat of perjury penalties, came just two weeks after the SEC proposed a broader but less onerous rule that all CEOs and CFOs sign each 10-Q and 10-K, certifying--but not swearing--that the report is correct and complete.
That rule--which is still on the table--poses less of a personal threat to CFOs, who are already required by the SEC to sign quarterly and annual reports. The SEC notes that the rule "creates a new legal obligation for [CFOs and CEOs], but does not change the standard of legal liability."
The question now is, will the SEC revert to the proposed certification rule next year? If so, just what would change for finance chiefs?
For starters, the SEC clearly hopes your boss will develop a keen appetite for finance minutiae. "The CEO is going to be in the CFO's office a lot more," speculates Hagerman.
"The SEC is trying to nail down the fact that signing a financial statement is a very intentional, solemn act," adds Stanley Sporkin, a retired judge and former head of the SEC's Division of Enforcement. The proposed certification rule, says Hagerman, would codify the Ninth Circuit Court's ruling in Howard v. Everex Systems Inc., which holds company officers responsible for the contents of documents they sign.
Clearly, the SEC is fed up with protestations of ignorance from officers like former Enron CEOs Jeffrey Skilling and Kenneth Lay. Forcing officers to sign their company's financial documents, says Sporkin, "is like pushing a dog's nose in his urine."
Perhaps. But will investors soothed by sworn oaths accept the simpler certification after the SEC's order expires? One SEC staffer, speaking anonymously, says of the certification rule, "I think it is window dressing. I don't know what it adds beyond [CEOs and CFOs] having to sign the 10-K." After Enron and WorldCom, investors, sick of seeing company officers taking oaths in front of Congress, might insist that they take them regularly in their offices instead. --Tim Reason
Accounting's Perfect Storm
WorldCom's revelation in June that it improperly allocated $3.9 billion in expenses during the past five quarters, or longer, set a low-water mark in the current tide of accounting scandals. Most likely it's not the lowest. And identifying the next scandal may simply be a process of wading through the risk factors.
Robert Simons, a professor at Harvard Business School, suggests that a confluence of events has created a climate in which accounting fraud isn't just possible, it's likely. This, he says, is accounting's perfect storm: the conjunction of unprecedented growth with inordinate incentive compensation, executive inexperience, and an extremely aggressive management culture. "Taken individually, some of these may be good news. But when they all come together, it's a disaster waiting to happen," says Simons, who has developed a Risk Exposure Calculator to gauge the degree of each factor.
There's no denying that many of these risk factors exist today. The intense growth of the late 1990s, coupled with investors' keen focus on profits, has placed a strain on many corporate officers. "As management comes under increasing pressure, a mentality develops of 'make the numbers at almost any cost,'" says Simons. At companies that didn't make the numbers, even by as little as a penny, the stock price tanked and put CEOs' and CFOs' jobs at risk, he adds.
Pressure to make the numbers was especially intense at WorldCom, which was growing at breakneck speed (an average of 58 percent per year from 19962000), mostly through acquisitions. In fact, CFO magazine singled out then-CFO Scott Sullivan in 1998 for excellence in M&A, after he and then-CEO Bernard Ebbers pulled off the biggest merger up until that time with the purchase of the much-larger MCI.
That kind of growth is exceedingly difficult to manage. "When a company is growing that fast, [managers] are struggling to keep their heads above water just to run the business," says Peter McLean, an executive recruiter at Spencer Stuart. "It comes at the expense of good, solid operating procedures."
At WorldCom, the pressure for growth was compounded by management inexperience. While still in his mid-30s, Sullivan was suddenly controlling the finances of one of the largest companies in the United States. "There is a sense of hubris that develops among managers that they are these great heroic figures, and that they are almost invincible," says Simons.
In addition, WorldCom's faulty information systems made it far from invincible. The firm completed more than 60 acquisitions in a short period of time. "Accounting for those gets complex," says Simons. "It's difficult to do trend analysis." Moreover, assimilating so many firms often leads to a culture in which information doesn't flow up, because managers have different allegiances. "At a broken company, people don't tell the truth," says Steve Priest, president of the Ethical Leadership Group. "They either fear retaliation or think that no one will listen."
Greed And Ego
Still, despite all of these risk factors, individual executives have a responsibility to conduct themselves with integrity. And while plenty of CFOs feel pressure to fudge the numbers, only a small minority do so. "Ultimately, it comes down to greed and ego," says Frank Borelli, retired CFO of insurer Marsh Inc. "In these cases [of accounting fraud], CEOs and CFOs lost sight of their fiduciary responsibility to shareholders and focused on building wealth for themselves." Indeed, Sullivan received a $10 million retention bonus in 2000, and reportedly cashed in stock worth $30 million during his tenure at WorldCom.
While Sullivan's actions are indefensible, clearly the system of checks and balances broke down around him as well. "Our free-market system does not depend on executives being saintly or altruistic," says Simons. "But markets do rely on institutional mechanisms, such as auditing and independent boards, to offset opportunistic, not to mention illegal, behavior." Perfect those controls, and companies should be able to weather any storm. --J.McC.
WorldCom shares have dropped from a high of $64.5 in June 1999 to a recent low of 10 cents, costing investors more than $185 billion.
Arthur Andersen, reporting to the audit committee on WorldCom's 2001 financials, noted "no unusual transactions."
Now Everyone's a Target
On July 2, pharmaceuticals giant Merck & Co. was hit with a class-action securities lawsuit filed by Milberg Weiss Bershad Hynes & Lerach LLP, one of the most notorious class-action securities law firms. The suit marks a huge departure from the typical targets of securities suits: technology firms.
And Merck is not the only new target. A recent study by PricewaterhouseCoopers LLP shows that a lower portion of securities litigation cases filed so far this year involve high-tech companies. Instead, suits involve an array of industries, including energy, pharmaceuticals, and retail. "No publicly traded company is immune," says Charles Laurence, a partner at PwC. Roughly two-thirds of securities suits in the first half of 2002 have been brought against nontech companies, he notes.
That trend does not surprise Kimberly Pinter, director of corporate finance and tax at the National Association of Manufacturers. "It has to do with a general decline in the stock market," she says. "The biggest driver is still the stock price going down."
Not so, argues Melvyn Weiss, senior partner at Milberg Weiss. "The reality is that many non-high-tech companies are fooling around with their financials," he contends. He adds that the popularity of using stock options outside the tech sector has put pressure on more companies to artificially inflate results.
There have been 114 securities suits filed through June of this year, according to a Web site maintained by Stanford University (http://securities.stanford.edu). A record 483 securities suits were filed last year. However, 308 of those involved disputes over the allocation of initial public offering shares--so-called laddering cases. Of the remaining suits, a record 57 percent included allegations of accounting improprieties. As recent headlines suggest, that trend has continued.
The securities suit against Merck, for example, alleges that the company's Medco unit boosted revenue by billions of dollars by improperly including copayments made to pharmacies that it never received. In the past Merck has defended the practice, which does not affect earnings, and claims that two independent auditors reviewed the procedure without objections.
The PwC study also finds that more New York Stock Exchange companies and foreign companies are being named in suits. "What is stunning is the number of cases against Fortune 500 companies," adds Weiss. In the past year, Kmart, Halliburton, Merrill Lynch, Ford, and several others have been targeted. --J.McC.
I Gave At The Office
Nearly $10 billion is raised each year through employee-giving campaigns, and the programs are growing by 10% annually, according to KindMark.
For Richer or for Poorer
Last year, Gary Crittenden, CFO of American Express Co., earned more than $4.6 million, including almost $3 million in stock options. Yet the company's stock price slid from $52 to $35.7--a 31 percent decline. Former Amazon.com Inc. CFO Warren Jenson reaped a cash bonus at the end of 2001 worth more than $1.5 million, despite a simultaneous 22 percent drop in the online retailer's stock.
There are endless examples--including the well-documented cases at Enron and WorldCom--of executives getting rich while their companies go broke. And the large payouts for nonperformance have angered investors. "With the concept of pay for performance, when the market goes down pay should go down as well," says Anne Yerger, research director for the Council of Institutional Investors. "But in many cases, companies are making up for the shortfall with other types of compensation," she says, including options and corporate loans.
Ed Archer, managing director at executive compensation consultants Pearl Meyer & Partners, warns against being fooled by anecdotal evidence. "The reality is that overall, cash bonuses are down about 20 to 25 percent." He says, too, that a higher percentage of CFOs are getting no bonus at all. Many of the well-publicized multi-million-dollar packages are from stock options awarded during the banner years.
Still, some compensation experts are cautioning against performance-based incentive plans that provide executives with windfalls during good times but don't punish them when returns are poor. Todd McGovern, Midwest director of compensation at Buck Consultants, says another problem is that many executive-performance systems don't differentiate between the individual performance of top executives, but reward them equally. "There is a disconnect between pay and performance," he says, "especially on the downside." -- J.McC.
What Drives Executive Pay?
Source: Buck Consultants
Acquisitions were made by 2,247 public companies in the first half of 2002, the least since 1996, according to Mergerstat.
Running Out of Options
CFO Bud Robertson got a rude shock in April when investors at the company's annual meeting voted down his plan to replenish Progress Software Corp.'s stock-option pool. He now faces a dilemma about how to compensate his employees, all of whom normally receive options. "We have enough options to do most of this year's grant," he says, "but next year it could be a big problem."
Robertson knew before the meeting that Institutional Shareholder Services (ISS), a proxy advisory group, had counseled large investors to vote against the options. Progress's overhang--the percentage of total shares represented by outstanding options--already exceeded the level ISS considers acceptable. "We knew going in that the vote was going to be close," he says. "One or two big shareholders can swing it the wrong way."
But he also thought he could convince enough large investors to disregard ISS's position on the options overhang, as he had two years earlier. He argues that the overhang is largely caused by stock buybacks, a five-year vesting period, and his employees' tendency to hold their options--all of which investors applauded. And Progress is no dot-com start-up. The Bedford, Mass.-based firm is profitable, has $191 million in cash (conservatively invested), and last year produced a 32 percent return, while its peer group lost 29 percent.
But times--and proxy committees--have changed. "People who would listen to reason before won't now," says Robertson. He believes proxy committees are now rigidly adhering to ISS guidance to protect themselves in the event of a shareholder lawsuit.
"What's changed is not that investors are slavishly following our recommendations this year," counters Patrick McGurn, an ISS vice president. "They're just not buying the arguments being made by issuers." Institutional investors may have waived their guidelines in the past, he adds, but now they have hardened their stance. "I think we have seen a permanent change in the difficulty some companies will have getting shareholders to approve additional [option] allocations."
Progress's experience, he contends, is a common one. "Votes against [option] plans have been rising on a regular basis," says McGurn. "Blame it on Enron, not ISS." Selling investors on a firm's specific merits is a matter of trust, he says, "and the trust level is quite low right now." --T.R.
Three out of five investors are convinced that companies are purposely withholding information from the public to maintain their stock price, reports a survey by InsightExpress.
Beast or Burden?
Who's going to stop auditors from pussyfooting around aggressive accounting tactics? If the Securities and Exchange Commission has its way, a new nine-member board will be in place by the end of the year to do just that. The proposed new Public Accountability Board would replace the now-defunct Public Oversight Board and conduct annual, rather than triennial, probes of large audit firms.
In announcing the new board, which will include at least six nonaccountants, SEC chairman Harvey Pitt claimed it "will help restore investor faith by ensuring strong and effective regulation." Subject to any changes made during the proposal's comment period, the board would also have the power to levy fines and bar accountants from the profession.
While the American Institute of Certified Public Accountants carps that the SEC "may have gone too far," most CFOs view the proposal as good news. "Anything that helps restore investor confidence is a good thing," says Kevin Thompson, CFO of Red Hat Inc., a Raleigh, N.C.-based Linux provider. Thompson is a former partner with, and current audit client of, PricewaterhouseCoopers.
Others fear, however, that it may be too much of a good thing. Although the SEC promises that the board "would not conduct any roving investigations of public companies," it would probe audit firms' procedures for selecting clients, rotating audit personnel, and allowing partners to accept employment from clients. "We have to be very careful that it doesn't reach too far," says former Deloitte & Touche partner Stephen Giusto, now CFO of Deloitte spin-out Resources Connection Inc. "If there's no indication that we're doing something inappropriate, I don't think they have any right or reason to look at our records."
Like so many reforms, though, the move has turned into a political battle. Calling the SEC's proposal a "toothless tiger," Senate Democrats are promoting their own legislation, which would create a similar though smaller board, and would also restrict audit firms from practicing certain types of consulting. -- Alix Nyberg
Auditing firms gave a clean bill of health to 94% of companies that were later cited for accounting errors, says Weiss Ratings.
Don't Go with the Flow?
It has long been suggested that recessions are the perfect time for companies to up their spending rather than curtail it. Layoffs and bankruptcies release huge amounts of valuable assets into the marketplace at bargain prices, while the specter of shrinking revenues keeps rivals on the sidelines. Yet, as the current protracted clampdown on corporate spending shows, not everyone buys into such thinking.
Now, there's documented evidence to support the claim that selectively boosting spending during a downturn can pay off in spades. An analysis of nearly 20 years of data for more than 1,000 U.S. companies by consulting firm McKinsey & Co. recently found that those that emerged from the 199091 recession ahead of their competitors in relative stock rating and financial performance had typically spent more in areas like SG&A and M&A during the downturn, but less than rivals during the boom. "When other companies simply battened down the hatches, the more successful competitors found opportunity and pressed their advantages," says lead author Richard Dobbs, a partner in McKinsey's London office.
Dell Computer Corp. is one company that used the last recession to grow. After upping its invested capital by 60 percent per year during the slowdown, by 1992 Dell had quadrupled its prerecession market share and outperformed the S&P index for its industry. Other savvy countercyclical spenders include Intel, Duke Energy, and Southwest Airlines.
"You can't use current economic conditions as an excuse for not growing," says Borland Software Corp. CFO Fred Ball, who put contrarian spending into practice at the $221 million software development tools provider. Despite the worldwide slowdown in IT expenditures, Borland upped spending on sales and marketing by 13 percent in 2001. The company also ramped up its M&A team to complete three all-cash acquisitions in the past 18 months. Meanwhile, Borland's stock price has more than doubled since mid-2000.
Of course, spending alone doesn't guarantee success. According to the study, the optimal strategy for a company is dependent on its position prior to the recession. For example, although leaders that stayed leaders boosted spending in areas like R&D and advertising, low-ranked companies that moved up actually cut back on such costs during the recession. --A.N.
The Great Liquidation
In 2001, U.S. firms cut inventories by a massive $234 billion. It was the largest sell-off in more than 50 years, according to the Federal Reserve Bank of New York.
Workers' Comp Costs: The Rising
Blame the insurance cycle. After years of palatable increases and even some decreases, workers' compensation costs are jumping up again. Fueled by an increase in underlying health-care costs and a higher number of claims--not to mention the impact of September 11--workers' comp costs bumped up an average of 12 percent this year, according to Stephen Lowe, a managing principal at consultancy TillinghastTowers Perrin.
"In the past, inflationary pressures were offset by managed-care efforts," says Lowe. "But that process has run its course." Lowe says that managed care can still be effective, but employers need to refocus their efforts. "A lot of people have become complacent," he says.
Not everyone. Companies are turning to workers' comp health-care organizations (HCOs)--which oversee the delivery of medical care--in greater numbers. In Florida, for example, the number of employees who are covered by HCOs has doubled since last September. In California, HCO legislation allows employers to determine the course of an employee's treatment for 90 to 180 days, up from the previous limit of 30 days. The extra time allows more claims to be settled quickly (95 to 97 percent in 180 days versus less than 20 percent in 30 days), says Donald Balzano, CEO of Long Beach, Calif.-based Medex HCO.
Mike Campbell & Associates, a City of Industry, Calif., warehouse and distribution company, cut rates by 50 percent since it started working with Medex, says general manager Kevin McHugh.
Companies will need all the help they can get. Lowe predicts the workers' comp rates will continue to rise over the next few years. "The terrorism issue has yet to be resolved," he says, "and insurance companies will continue to focus on the bottom line." -- Joan Urdan